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Pooled resources – Neither good nor bad times last forever

03/01/2013

Kevin Murphy

Fund Manager, Equity Value

Platinum is some 30 times rarer than gold. Unlike gold, however, which has enjoyed a huge boom, demand for platinum has – despite its additional rarity – weakened. As a result, mining companies are going through a tough time, essentially being squeezed by the pincers of falling commodity prices and labour inflation.

The rarity of the world’s precious metals can be illustrated in lots of ways but a powerful one relates to how many Olympic-sized swimming pools would be filled by the total amount of any type ever discovered. So, for example, while it has been captivating the world for thousands of years, all the gold ever mined in that time would still only fill two and a half pools.

For its part, platinum is some 30 times rarer than gold. It was discovered just a few hundred years ago, may be found in only a handful of places around the world and is also pretty tricky to get out of the ground. As such, if you were to put all the platinum that has ever been mined into an Olympic-sized swimming pool, it would barely be ankle-deep.

Like gold, only a finite amount of platinum exists in the world and nobody is making any more of it. Unlike gold, however, which has enjoyed a huge boom, demand for platinum has – despite its additional rarity – weakened. Platinum’s principal uses are in jewellery and catalytic converters for cars, both of which have come under cyclical pressure in recent years.

The platinum industry has subsequently being going through a tough time – and not just because of the recent slight decline in platinum prices. On the other side of the profit and loss equation, the previous steep rise in platinum prices pulled up labour costs and – as we have noted before in articles such as Emerging risk – they will not be heading down again just because commodity prices are adjusting.

Mining companies are essentially being squeezed by the pincers of commodity prices and labour inflation and the resulting pressure has been evident in the recent issues Lonmin has faced in getting away an $817m (£513m) rights issue that will enable the world’s third largest platinum producer to continue in business.

A key factor in this has been the initial hesitation of Xstrata, the group’s largest shareholder to back the move. The interesting aspect of Xstrata apparent reluctance to buy into the rights issue at £1.40 a share is that back in 2008, as we discussed in a previous article, it tried to buy the whole of Lonmin for £62 a share, eventually settling for 25% of the company at £36 a share.

The way economics is meant to work is that businesses that struggle to cope with changing times eventually leave their industry, thereby reducing the supply of what they used to produce while increasing demand for the surviving players. At the same time, the theory continues, the simultaneous reduction in demand for labour should help drive down costs for the rest of the market.

Only time will tell if this is how things play out for the platinum industry so we will simply aim here to draw one value-oriented conclusion from the story so far. In the context of platinum mines enjoying a lifespan of maybe two or three decades, the five years it has taken for Xstrata to blow hot then cold about Lonmin is a relatively short period of time.

History proves time and again that neither people nor companies excel at forecasting the future. As value investors, we settle for acknowledging that times do change, which means that good times do not continue forever – but then neither do bad times.

Author

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials. In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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